FX HORIZONS: From the Streets of Sao Paulo and Istanbul, a Lesson in Political Economy

The spontaneous eruption of anger from thousands of young protesters in Turkey and Brazil this past month was a bit baffling to foreign observers.

Until recently, both countries were seen as shining examples of emerging market progress, places of rapid growth where a rising middle class could look to a brighter future.

So why the angst? Why did the beneficiaries of this emerging middle class suddenly rise up? And what does it mean for continued world growth?

There are no easy answers, but a good place to start is the four-way intersection of economic inequality, political privilege, inflation and slowing global growth.

Until now, globalization has done a reasonable job of lifting all boats in emerging markets. World-wide, poverty has fallen and infant mortality, literacy and wellness have all improved. But advancement has happened very unevenly within and across countries. And as the capacity to make more money by those in positions of power has increased, so too has the scope of corruption and of enrichment via government-created market distortions. Not only does this inequity become more glaring as growth advances, but history shows that a more educated and politically active middle class will over time raise their expectations for change and demand it.

By that score, Brazil was ripe for unrest. While unemployment is at record lows, its Gini coefficient, a measure of inequality, stands at 54, one of the highest in the world. No surprise, then, that a chart produced by Eurasia Group this week showed how the top concerns among surveyed Brazilian voters went from a “lack of jobs” in 2005 to “quality of life” issues related to healthcare, transportation, crime and education in 2013.

Meanwhile, both Turkey and Brazil are running annual inflation at an uncomfortably high 6.5%. And the effect tends to skew even higher in sensitive sectors such as housing and food in the most populous cities. Rents in Rio de Janeiro and Sao Paulo have at times approached those of New York; Istanbul now ranks it one the most expensive cities in the emerging market world – ahead of Shanghai, Beijing and Mumbai – according to a cost-of-living index from expatriate services site Expatistan. com. This is a recipe for discontent.

The social cleavages created by these distortions tend to develop over time, but the anger and activism usually arrive as an explosion, triggered by what seem like isolated, almost innocuous events – the 10-cent bus fare hike in Sao Paulo; the redevelopment plan for Istanbul’s Gezi Park. Importantly, though, these moments often arise when the economy begins to sour.

Cue the slowdown in China, which is now holding back growth everywhere as Europe and the U.S. continue to struggle with recovery from their respective crises. A decade-long advance in average emerging market incomes, a phenomenon only briefly interrupted by the global financial crisis, is now grinding to a halt. It’s as if the music has stopped and the emerging middle classes suddenly realize the seats have all been reserved for the rich.

Years back, economic theory tended to ignore these issues. Social inequality was considered a moral concern but of no consequence to economic performance while corruption, though distasteful, was often viewed as a necessary evil that greased the wheels of commerce. Now, however, we have reams of research demonstrating the deleterious effect of both on a country’s growth potential. Policymakers must address them or risk economic stagnation.

Yet doing so is no easy task. As Harvard economist Edward Glaeser points out, placating angry protesters with retrograde measures – as with the move to roll back bus fare hikes in Brazil — can sometimes do more harm than good as they introduce more market distortions, which in turn leads to more inefficiencies and inequities.

The real solution is to break down the subsidies and favorable tax treatment that governments provide to privileged elites—the rent-seeking class, as economists call them. In Brazil that means weaning favored industries off decades of subsidized state finance. In Turkey, the targets lie among the crony capitalists that thrived off a militarized state for decades and which, more recently, have exploited Islamist ties to the government of Recep Tayyip Erdogan.

But to fully attack inequality and the resultant barriers to progress requires a global approach. Preferential tax and subsidy policies in developed countries are guilty of creating the same privileged classes — just think of the exorbitant salaries paid by multinational, too-big-to-fail banks. And as much as Federal Reserve Chairman Ben Bernanke denies it, there’s compelling evidence that rich countries’ “quantitative easing” programs have stoked the property bubbles that have marginalized the poor and lower middle class in places like Sao Paulo.

With the debt-laden, aging economies of the developed world facing limits to future growth, we need emerging market growth more than ever. Attacking what irks the citizens of Sao Paulo and Istanbul should be a goal we all share.